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Should I Convert My IRA to a Roth?

You may recall that, a few years ago, a tax rule went into effect that allows anyone, regardless of their income or tax filing status, to convert a Traditional IRA to a Roth IRA. So why would anyone want to?

Primarily, it’s because of the Roth’s tax advantages and its lack of minimum required distributions. In a Roth, your earnings grow completely tax-free, not just tax-deferred as in a Traditional IRA. And since you don’t have to begin making withdrawals at age 70-1?2 like you do with a Traditional IRA, earnings could grow tax-free for an even longer period of time. There’s a cost to converting to a Roth, however: You’ll owe taxes on the amount converted that was contributed pre-tax or was tax-deductible.

So how do you know if it’s a good idea for you? Ask yourself these three questions:

Do I think my tax rate will be higher or lower in retirement?This is a tough one, because no one has a crystal ball that shows the tax code years from now. But if you believe you’re in a lower tax bracket now than you will be in retirement, converting and paying the taxes now might make sense.

Do I have time on my side? If you have at least five or 10 years until retirement, converting might look good to you for two reasons. First, the money needs to stay in the Roth IRA for at least five years for your earnings to be withdrawn tax-free. Second, you need to have enough time ahead of you to make sufficient tax-free earnings that more than offset the immediate income tax effect.

Do I have the money to pay the taxes?Experts warn, don’t use money from the IRA to cover the taxes due on the conversion. The potential penalties if you’re less than age 59-1?2, coupled with the loss in tax-free earnings on that money, will probably erase the benefit of converting in the first place.

There are many other considerations with this new tax rule. Your best bet: Speak to a competent, trusted tax advisor about your specific situation.